Issue No: 03-1 Title: The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments

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1 EITF Issue No The views in this report are not Generally Accepted Accounting Principles until a consensus is reached and it is FASB Emerging Issues Task Force Issue No: 03-1 Title: The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments Document: Working Group Report No. 3 * (Supplement No. 5) Date Prepared: October 23, 2003 FASB Staff: McBride (ext. 384)/Durbin (ext. 296) Dates Issue Previously Discussed: September 11 12, 2002; November 21, 2002 (discussed as part of Issue 02-14); January 23, 2003; March 20, 2003; May 15, 2003; July 31, 2003 Previously Distributed EITF Materials: Issue Summary No. 1 of Issue 02-14, dated August 26, 2002; Issue Summary No. 1, Supplement No. 1 of Issue 02-14, dated November 11, 2002; Issue Summary No. 1, dated January 10, 2003; Working Group Report No. 1 (Supplement No. 1), dated March 7, 2003; Working Group Report No. 2 (Supplement No. 2), dated May 2, 2003; Issue Summary No. 1, Supplement No. 3, dated July 16, 2003; Issue Summary No. 1, Supplement No. 4, dated July 29, 2003 References: FASB Statement No. 7, Accounting and Reporting by Development Stage Enterprises (FAS 7) FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (FAS 91) FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115) FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations (FAS 124) * The alternative views presented in this Working Group Report are for purposes of discussion by the EITF. No individual views are to be presumed to be acceptable or unacceptable applications of Generally Accepted Accounting Principles until the Task Force makes such a determination and it is EITF Issue No Working Group Report No. 3, p. 1

2 FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133) FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140) FASB Statement No. 142, Goodwill and Other Intangible Assets (FAS 142) FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (FAS 144) FASB Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities: Questions and Answers (Q&A on FAS 115) EITF Issue No , "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" (Issue 99-20) EITF Abstracts, Topic No. D-86, "Issuance of Financial Statements" (Topic D-86) APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (APB 18) AICPA Practice Bulletin No. 6, Amortization of Discounts on Certain Acquired Loans (PB 6) AICPA Accounting and Auditing Guide, Health Care Organizations (Health Care Guide) SEC Staff Accounting Bulletin No. 59, Accounting for Noncurrent Marketable Equity Securities (SAB 59) EITF Issue No Working Group Report No. 3, p. 2

3 Introduction 1. At the July 31, 2003 EITF meeting, the Task Force discussed separate other-than-temporary impairment models for each of the following categories of investments: (a) FAS 115 and FAS 124 equity securities, (b) FAS 115 and FAS 124 debt securities, (c) cost method investments (that is, equity securities that are not subject to the scope of FAS 115 and not accounted for under the equity method), and (d) equity method investments. 2. The Task Force generally supported the underlying principles in each of the proposed impairment models for equity securities, debt securities, and cost method investments. However, the Task Force suggested further refinement to those models to, among other things: a. Eliminate the rebuttable presumption that an impairment is considered other-than-temporary after a one-year period of impairment b. Further emphasize the notion that the weight of evidence indicating an impairment is otherthan-temporary increases as the length of time that a security's fair value is below its cost or amortized cost increases and, therefore, that greater positive evidence will be required to conclude that an impairment is temporary as the duration of impairment increases c. Require the investor to disclose in its financial statements information about unrealized holding losses that have not been recognized as other-than-temporary impairments. 3. In addition, the Task Force suggested that the proposed impairment model for debt securities be further refined to clarify the intent and operation of the proposed model for investments in debt securities with noncontingent contractual cash flows. In particular, the Task Force agreed on the general principle that impairments due to deterioration in credit that result in a conclusion that noncollection is probable should be considered other-than-temporary. Other declines in fair value (for example, due to interest rate changes, sector credit rating changes, or company-specific rating changes that do not result in a conclusion that noncollection of contractual principal and interest is probable) may not result in a conclusion that an other-thantemporary impairment has occurred, subject to the other considerations in the proposed model. Therefore, the Task Force asked the Working Group to further refine Step 2 of the model for debt securities to differentiate those securities for which noncollection is probable from those EITF Issue No Working Group Report No. 3, p. 3

4 securities for which collection is probable but that, based on other considerations, may be considered other-than-temporarily impaired. The Task Force also requested that the Working Group develop further guidance for determining what constitutes "noncontingent contractual cash flows." 4. For cost method investments, because fair value is not readily determinable, the Task Force generally agreed that investments should be tested for impairment annually, or more frequently if certain indicators are present, rather than at each reporting date. However, because information necessary to estimate the fair value of a cost method investment may not be readily available to the investor, some Task Force members requested consideration of an alternative model that would require an impairment test only when certain indicators are present. 5. The Task Force deferred further consideration of an impairment model for equity method investments until the impairment models for the other types of investments have been further refined. 6. In addition, the Task Force requested further consideration of the implications of including within or excluding from the scope of this Issue (a) investments of not-for-profit organizations and (b) beneficial interests in transferred financial assets subject to the scope of Issue Some Task Force members also requested clarification of the classification, for purposes of this Issue, of investments in mutual funds that invest in debt securities and suggested that the classification follow the guidance in Question 5 of the Special Report on FAS 115, which indicates that an investor should not "look through" the form of an investment to the underlying investments of the investment vehicle. 7. On September 17, 2003, the Working Group for Issue 03-1 met for the third time and discussed further refinements to the impairment models proposed previously in Issue Summary No. 1, Supplement No. 3. The following includes a summary of the specific issues discussed by the Working Group and any related recommendations. Where applicable, the recommendations have been incorporated into the impairment models proposed in the Exhibits to Issue Summary No. 1, Supplement No. 3, which are included herein and marked for changes. EITF Issue No Working Group Report No. 3, p. 4

5 Emphasizing the Weight of Evidence Notion, Eliminating the One-Year Rebuttable Presumption, and Eliminating the Requirement for Objective and Verifiable Evidence 8. The Working Group discussed the elimination of the rebuttable presumption that an impairment be considered other-than-temporary after a one-year period and the notion that an impairment is considered other-than-temporary unless there is objective and verifiable positive evidence that outweighs objective and verifiable negative evidence to the contrary. The Working Group acknowledged that for investments in marketable equity and certain debt securities, the only positive objective and verifiable evidence that generally would be available to overcome the presumption that an impairment is other-than-temporary would be a substantial recovery in fair value after the balance sheet date but prior to the issuance of the financial statements. The Working Group therefore believes that guidance that requires objective and verifiable evidence would likely result in a lower of cost or market model. 9. The Working Group believes that whether an investor should deem an impairment otherthan-temporary is a matter of judgment that depends on the relevant facts and circumstances. To assist an investor in making that determination, the Working Group believes that this Issue should provide guidance that should be considered by the investor in performing the requisite evaluation. The Working Group continues to support the notion set forth previously in Issue Summary No. 1, Supplement No. 3: An impairment shall be deemed other-than-temporary unless evidence indicating that the investment's cost or amortized cost 1 is recoverable within a reasonable period of time outweighs evidence to the contrary. The Working Group recommends that an investor make an evidence-based judgment about the realizability of a market price recovery up to (or beyond) the cost of the investment by considering: (a) the investor's ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment, (b) the severity of the impairment, (c) the duration of the impairment, and (d) evidence about a forecasted market price recovery. 1 Cost or amortized cost referred to herein includes adjustments made to the cost basis for previous impairments, foreign exchange and hedging. EITF Issue No Working Group Report No. 3, p. 5

6 The revisions to the models are reflected in each of the attached Exhibits. Exhibit 03-1A provides examples of how to apply the model. 10. In order to support the conclusion that an investment is not other-than-temporarily impaired, the model requires, among other things, that the investor assert that it has the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment. The Working Group observed that, similar to held-to-maturity securities under FAS 115, an investor's assertion about its intention to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment could be called into question if its intention is subsequently changed. The Working Group observed that a strict "tainting" standard similar to FAS 115 would result in recognizing unrealized losses on available-for-sale securities in the income statement, but unlike a trading security, would not allow recognizing unrealized gains in the income statement. Therefore, the investor's assertion under this Issue may take on more significance than the investor's assertion under FAS 115. Accordingly, the Working Group recommends that the Task Force consider an observation that a pattern of selling investments prior to the forecasted market price recovery, while not presumptive, may call into question the investor's intent. Definition of Non-Contingent Contractual Cash Flows and Refinement of Step 2 of the Debt Securities Model 11. The Working Group discussed the intent and operation of the debt securities impairment model in identifying securities with so-called "non-contingent contractual cash flows." The intent of that determination is to identify securities in which the investee is required to settle the security in such a way that the investor would recover substantially all of its amortized cost. The investor's ability to realize a market price recovery is therefore dependent upon (a) the investee's ability to satisfy its obligation (collectibility) and (b) the investor's ability and intent to hold the investment to the earlier of (i) settlement or (ii) a market price recovery. This distinction allows investors of high-quality debt instruments (for example, U.S. Treasuries) to evaluate recovery based on collectibility, subject to the investor's ability and intent. If an investee can settle the EITF Issue No Working Group Report No. 3, p. 6

7 security in such a way that the investor would not recovery substantially all of its amortized cost, then similar to an equity security, the investor's ability to realize a market price recovery is dependent upon a number of factors (for example, interest rate changes, sector credit rating changes, or company-specific rating changes) in addition to collectibility. 12. The Working Group therefore recommends that this Issue separate debt securities for purposes of the impairment test based on whether a security could be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost. If a security cannot be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost, then the investor shall deem an impairment other-than-temporary if it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the investment. If a security can be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost, then the investor shall deem an impairment other-than-temporary if evidence indicating that the investment's amortized cost is recoverable within a reasonable period of time does not outweigh evidence to the contrary. Examples 2-6 in Exhibit 03-1B illustrate the evaluation of whether a security could be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost. 13. A Working Group member observed that an investor may be entitled to the benefits of a guarantee or other credit enhancement related to a debt security that could not be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost. The Working Group member questioned whether a guarantee or other credit enhancement that provides for payments to be made solely to reimburse the investor for failure of the investee to satisfy its required payment obligations should be considered in the investor's determination of whether it is probable that it will be unable to collect all amounts due according to the contractual terms of the debt security. The Working Group recommends that the investor only consider a guarantee or other credit enhancement in determining whether it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security if (a) the guarantee or other credit EITF Issue No Working Group Report No. 3, p. 7

8 enhancement provides for payments to be made solely to reimburse the investor for failure of the investee to satisfy its required payment obligations and (b) the guarantee or other credit enhancement cannot be separated from the security. Examples 7-10 in Exhibit 03-1B illustrate how an investor should apply this concept. 14. Similarly, an investor may have a debt security that, when combined with a financial instrument such as an interest rate option, cannot be settled in such a way that the investor would not recover substantially all of its amortized cost. The Working Group recommends that an investor not combine separate contracts for purposes of determining whether a debt security cannot be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost. Example 11 in Exhibit 03-1B illustrates how an investor should apply this concept. Implications of Including Within or Excluding From the Scope of Issue 03-1 Investments within the Scope of Issue The Working Group discussed the implications of including within the scope of Issue 03-1 investments within the scope of Issue The Working Group observed: a. Under the guidance in Issue 99-20, an investor may conclude that a security is not other-thantemporarily impaired, even when the investor has neither the ability nor the intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment. Issue 03-1, therefore, provides the investor with an incremental consideration; that is, whether the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment. b. Developing estimates of future cash flows required by Issue requires that the investor evaluate factors such as collectibility, credit risk, and changes in interest rates. Since Issue 03-1 requires the consideration of those same factors in determining either (a) the probability that the investor will be unable to collect all amounts due according to the contractual terms EITF Issue No Working Group Report No. 3, p. 8

9 of the debt security, or (b) a forecasted market price recovery up to (or beyond) the amortized cost of the investment, Issue 03-1 is not incremental to Issue in this regard. c. Issue provides specific post-impairment accounting guidance ("Day 2 and Day 3"). Therefore, investors with investments under the scope of Issue should not follow Issue 03-1 for post-impairment accounting. d. Issue does not require disclosure about unrealized holding losses that have not been recognized as other-than-temporary impairments. However, under the guidance of Issue 03-1, investors with investments subject to the scope of Issue should provide the quantitative and qualitative disclosures required under Issue Accordingly, the Working Group recommends the following for securities included within the scope of Issue 99-20: a. The investor should consider whether a security is other-than-temporarily impaired under the guidance of Issue If the security is not other-than-temporarily impaired under Issue 99-20, the investor shall then determine whether the security is other-than-temporarily impaired under the guidance of Issue 03-1 (Exhibit 03-1B) solely by assessing whether the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment b. The investor should continue to follow Issue for post-impairment accounting c. The investor should provide the quantitative and qualitative disclosures required under Issue Example 1 in Exhibit 03-1B illustrates the application of the proposed Issue 03-1 Model for a security included in the scope of Issue New Alternative Step 1 for the Cost Method Model 16. The Working Group discussed Alternative 1C included in Exhibit 03-1C and observed that the nature of those indicators likely will result in the investor performing an impairment test every quarter. Therefore, the Working Group believes that Alternative 1C is not a cost- EITF Issue No Working Group Report No. 3, p. 9

10 beneficial alternative and recommends that the Task Force eliminate it from consideration. The Working Group also discussed Alternative 2C included in Exhibit 03-1C. While the Working Group agrees that the Alternative 2C impairment indicators provide for a more operational approach compared to the Alternative 1C impairment indicators, they questioned the requirement under Alternative 2C that an investor calculate the fair value of all cost method securities every year if impairment indicators are not present. 17. The Working Group therefore proposes another alternative to Step 1 for the cost method model, Alternative 3C (included in Exhibit 03-1C), which modifies Alternative 2C as follows: a. Eliminates the requirement to evaluate cost method investments for impairments every year (that is, estimating fair value and comparing to cost) b. Eliminates the ability to carry forward the impairment test from one period to the next c. Adds a requirement to perform a quarterly review of investments for the presence of impairment indicators (using the Alternative 2C impairment indicators), and to test for impairment if an indictor is present d. If an indicator is present and the investment is impaired, but the investor determines that the impairment is not other-than-temporary, Alternative 2C adds the requirement that the investor continue to support its evidence-based judgment at each balance sheet date until the investment is no longer impaired (due to either a market price recovery or the recognition of an other-than-temporary impairment). Disclosures about Unrealized Holding Losses That Have Not Been Recognized as Other- Than-Temporary Impairments 18. The Working Group discussed the relevance of quantitative and qualitative disclosures in the financial statements about unrealized holding losses that have not been recognized as otherthan-temporary impairments. While the Working Group acknowledges that disclosure is not a substitute for recognition of an other-than-temporary impairment when recognition is appropriate, the Working Group believes that disclosures can provide financial statement users EITF Issue No Working Group Report No. 3, p. 10

11 with useful information to understand the nature and risks associated with impaired investments and the investor's evidence-based judgments. 19. The Working Group recommends that investors disclose quantitative information about (a) the aggregate amount of unrealized losses, and (b) the aggregate related fair value of investments with unrealized losses, segregated into at least the following three time periods over which the investment has been in an unrealized loss position: (1) Less than 12 months (2) Twelve to 18 months (3) Greater than 18 months. 20. The Working Group also discussed qualitative disclosures about unrealized holding losses that have not been recognized as other-than-temporary impairments. The Working Group recommends that investors provide qualitative disclosures about the conclusion that impairments are not other-than-temporary, including: a. The nature of the investments b. The severity of the impairments c. The duration of the impairments d. The evidence that the investor considered (both positive and negative) in reaching the conclusion that the impairments are not other-than-temporary. 21. The quantitative and qualitative disclosures should be aggregated by each category of investment that the investor discloses in accordance with FAS 115 and FAS 124 (for example, equity securities, debt securities issued by the U.S. Treasury, and corporate debt securities). The Working Group also recommends that investors provide the quantitative and qualitative disclosures as of each fiscal year-end for which a statement of financial position is presented. 22. The Working Group discussed but rejected a proposal to require disclosure about the scheduled maturity dates for securities with fixed maturities that are in an unrealized loss EITF Issue No Working Group Report No. 3, p. 11

12 position. The Working Group noted that the disclosures required by FAS 115 provide sufficient information for financial statement users to understand the contractual maturities of such securities. 23. For investments in an unrealized loss position for more than 18 months, the Working Group discussed requiring that the investor disclose the range of how long investments have been in an unrealized loss position. The staff believes that disclosing the range may not provides investors with relevant information since it does not take into consideration the relative size of the investments in the range. Alternatively, for investments in an unrealized loss position for more than 18 months, the Task Force could consider requiring that investors disclose the weighted average life of how long investments have been in an unrealized loss position. 24. Under the proposed model for determining whether an impairment of a cost method investment is other-than-temporary, an investor is required to determine the fair value of an investment when an indicator is present. It is therefore possible that an investment's fair value is less than its cost without the presence of an indicator. Further, it is possible that an indicator becomes present after an extended period of time when the fair value is less than its cost. Accordingly, some Working Group members expressed a concern about providing an aging of unrealized losses because providing such information implies that (a) the amount of time that a cost method investment is in an unrealized loss position is definitive, and (b) the entire population of cost method investments in an unrealized loss position is complete. 25. Accordingly, the Working Group has put forth two views for the Task Force to consider on the disclosure about unrealized holding losses that have not been recognized as other-thantemporary impairments for cost method investments: View A: Provide only the recommended qualitative disclosures annually for cost method investments (that is, the basis for concluding that an impairment is not other-thantemporary). EITF Issue No Working Group Report No. 3, p. 12

13 View B: Provide the recommended quantitative and qualitative disclosures annually for cost method investments. In addition, the investor should disclose that, for cost method investments: (a) disclosures are limited to investments with impairment indicators, and (b) the aging of impairment is measured from the point that the impairment was first identified by the presence of an indicator. 26. Some Working Group members expressed concern regarding the amount of time investors would need to extract the disclosure data from their accounting information systems, and recommend that the Task Force consider transition guidance to provide investors sufficient time to modify their accounting systems to comply with the proposed disclosure requirements. Investments within the Scope of FAS The Working Group discussed the implications of including within the scope of this Issue investments within the scope of FAS 124. While FAS 124 does not specifically address otherthan-temporary impairments, it requires that all not-for-profit organizations report their investments in equity securities with readily determinable fair values and all investments in debt securities at fair value with gains and losses included in a statement of activities. The AICPA Audit and Accounting Guide, Health Care Organizations, requires health care organizations to report a "performance indicator" in the statement of activities. It states that unrealized gains and losses on securities classified as trading should be reported in the "performance indicator," while unrealized gains and losses on securities not classified as trading (that is, available-for-sale) that are deemed to be temporary be reported below the "performance indicator." Since unrealized losses on securities not classified as trading that are deemed to be other-than-temporary are reported in the "performance indicator," the Working Group recommends that investments within the scope of FAS 124 held by entities that report a "performance indicator" should be included within the scope of this Issue. Investments in Mutual Funds That Invest in Debt Securities EITF Issue No Working Group Report No. 3, p. 13

14 28. The Working Group recommends that, consistent with Q&A on FAS 115, Question 5, investors should not "look through" the form of their investment to the nature of the securities held by an investee. For example, an investment in a mutual fund that invests in debt securities would be classified as an investment in equity securities. "Day 3" Accounting Under the Debt Securities Model 29. Exhibit 03-1B included in Issue Summary No. 1, Supplement No. 3, did not address how the investor should account for increases in expected cash flows subsequent to the recognition of an other-than-temporary impairment. The Working Group recommends that the subsequent accounting be consistent with PB 6, which requires that the investor recognize an increase in expected cash flows subsequent to an other-than-temporary impairment prospectively as a yield adjustment over the remaining life of the investment. Modifications to the proposed models provided in Issue Summary No. 1, Supplement No. 3, are reflected in attached marked-text exhibits: Exhibit 03-1A Certain Marketable Equity Securities Exhibit 03-1B Certain Debt Securities Exhibit 03-1C Cost Method Investments EITF Issue No Working Group Report No. 3, p. 14

15 Exhibit 03-1A PROPOSED GUIDANCE FOR ASSESSING OTHER-THAN-TEMPORARY IMPAIRMENT FOR CERTAIN MARKETABLE EQUITY SECURITIES 1. This impairment model is applicable for investments in equity securities that are within the scope of FAS 115 2, as well as investments in equity securities that are within the scope of FAS 124 and that are held by an investor that reports a performance indicator as defined by the Health Care Guide. The following impairment model is summarized as a flow chart later in this exhibit. Step 1: Determine Whether an Investment Is Impaired. 2. An investment is impaired if the fair value of the investment is less than its cost. If an investment is impaired at the balance sheet date, a determination must be made as to whether that impairment is other-than-temporary (see Step 2). Step 2: Determine Whether an Impairment Is Other-Than-Temporary. 3. An impairment shall be deemed other-than-temporary unless: (a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment, and (b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. The investor shall make an evidence-based judgment about the realizability of a market price recovery up to (or beyond) the cost of the investment by considering the severity and duration of the impairment in relation to the forecasted market price recovery. 4. Investor s Ability and Intent. An impairment shall be deemed other-than-temporary unless the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment. 2 As indicated in paragraph 127 of FAS 115, insurance companies are required to report equity securities at fair value even if they don't meet the scope criteria in paragraph 3 of FAS 115. Therefore, this model would apply to all equity securities of insurance companies. 7 See Examples 3-8 in this Exhibit. EITF Issue No Working Group Report No. 3, p. 15

16 The investor should consider whether its cash or working capital requirements and contractual or regulatory obligations indicate that the investment will need to be sold before the forecasted market price recovery occurs. Although not presumptive, a pattern of selling investments prior to the forecasted market price recovery may call into question the investor s intent. 5. Severity of the Impairment. To evaluate the severity of the impairment, the investor shall assess the extent to which (a) fair value is below cost and (b) the event (or events) that gave rise to the impairment, to the extent identifiable, impacts the prospects of a market price recovery. An other-than-temporary impairment may occur in a very short time after the initial investment or establishment of a new cost basis if, based on all available evidence, the cost of the investment is not recoverable within a reasonable period of time. 6. Duration of the Impairment. Duration refers to the period of time that a security is impaired and the amount of time necessary for a market price recovery from the point of initial impairment. As the length of time that an investment is impaired increases, greater evidence will be required to conclude that an impairment is not other-than-temporary. There are practical limitations on the period of time an investor can incorporate into its forecast of market price recovery, notwithstanding its ability or intent to hold an investment for an indefinite future period. As the forecasted price recovery period lengthens, the uncertainties inherent in the investor s estimate increase, which impacts the realizability of that estimate. Therefore, greater evidence will be required to conclude that an impairment is not other-than-temporary the further the expected market price recovery is from the point of the initial impairment. 7. Forecasted Market Price Recovery. The investor should consider the following, among other things, in developing an evidence-based judgment about a forecasted market price recovery: A recovery in fair value after the balance sheet date but before the financial statements are issued A favorable change in the regulatory, economic, or technological environment of the investee, including the general market condition of either the geographic area or the industry in which the investee operates EITF Issue No Working Group Report No. 3, p. 16

17 Favorable forecasts about the investee s financial performance and near-term prospects, such as earnings trends, dividend payments, asset quality, and analysts or industry specialists forecasts. 8. While the relative weight of evidence should be considered in its entirety, either of the following could individually lead to a conclusion that an impairment is other-than-temporary: a. A recent but precipitous decline in market value, or b. A slight but protracted decline in market value. Step 3: Recognize an Impairment Loss Equal to the Difference between the Investment's Cost and Its Fair Value. 9. If it is determined in Step 2 that the impairment is other-than-temporary, then an impairment loss should be recognized in earnings equal to the difference between the investment's cost and its fair value at the balance sheet date. The fair value of the investment would then become the new cost basis of the investment and should not be adjusted for subsequent recoveries in fair value. Disclosures 10. For investments with unrealized losses that have not been recognized as other-thantemporary impairments, the investor shall disclose quantitative information about (a) the aggregate amount of unrealized losses, and (b) the aggregate related fair value of investments with unrealized losses, segregated into at least the following three time periods over which the investment has been in an unrealized loss position: (1) Less than 12 months (2) Twelve to 18 months (3) Greater than 18 months. 11. The investor shall also provide qualitative disclosures about the conclusion that impairments are not other-than-temporary, including: a. The nature of the investments b. The severity of the impairments c. The duration of the impairments EITF Issue No Working Group Report No. 3, p. 17

18 d. The evidence that the investor considered (both positive and negative) in reaching the conclusion that the impairments are not other-than-temporary. 12. The quantitative and qualitative disclosures should be aggregated by each category of investment that the investor discloses in accordance with FAS 115 and FAS 124 (for example, equity securities, debt securities issued by the U.S. Treasury, and corporate debt securities). Investors shall provide the quantitative and qualitative disclosures as of each fiscal year-end for which a statement of financial position is presented. EITF Issue No Working Group Report No. 3, p. 18

19 Flowchart Summarizing the Proposed Guidance in Exhibit 03-1A for Assessing Other- Than-Temporary Impairment for Certain Marketable Equity Securities No impairment NO Is the fair value of the investment less than its cost? Does the investor have the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment? NO YES Does evidence exist indicating that the cost of the investment is recoverable within a reasonable period of time that outweighs evidence to the contrary? NO Impairment is other-thantemporary. Recognize in earnings an impairment loss equal to the difference between the investment's cost and its fair value. YES Impairment is considered temporary. EITF Issue No Working Group Report No. 3, p. 19

20 EXAMPLES ILLUSTRATING THE DETERMINATION OF WHETHER EVIDENCE INDICATING THAT THE INVESTMENT'S CARRYING AMOUNT IS RECOVERABLE WITHIN A REASONABLE PERIOD OF TIME OUTWEIGHS EVIDENCE TO THE CONTRARY (APPLY TO ALL PROPOSED MODELS IN EXHIBITS 03-1A, B, AND C) Example 1 XYZ is developing a product that is highly anticipated by the market. On January 1, 20X2, Investor purchased 200,000 shares of XYZ stock at a cost of $20 per share. On May 1, 20X2, a regulatory body informed XYZ that the product did not meet certain regulatory requirements, and therefore would not receive the regulatory approval required to sell the product. On May 2, 20X2, XYZ issued a press release announcing the regulator s decision. XYZ s share price immediately declined from $22 per share to $11 per share, and traded in the $10 to $12 range through June 30, 20X2. No information is available to support a market price recovery up to (or beyond) the cost of the investment. Investor has the ability and intent to hold the investment for an indefinite period. Evaluation: Despite Investor s ability and intent to hold the investment for an indefinite period, Investor should deem the investment other-than-temporarily impaired given: The severity of the decline The absence of evidence to support a market price recovery up to (or beyond) the cost of the investment within a reasonable period of time. Example 2 Assume the same facts and circumstances as Example 1, with the following exception: On June 15, 20X2, XYZ announced that it had identified a way to modify the product in order to satisfy the regulatory requirements while maintaining the capabilities of the original product specification. XYZ s share price immediately increased to $17 per share, and traded in the $15 to $18 per share range through June 30, 20X2. EITF Issue No Working Group Report No. 3, p. 20

21 Evaluation: If, based on Investor s judgment, the announcement supports market price recovery up to (or beyond) the cost of the investment within a reasonable period of time, Investor would deem that the investment is not other-than-temporarily impaired. Example 3 Assume the same facts and circumstances as Example 1, with the following exceptions: On February 14, 20X2, a regulatory body informed XYZ that the product did not meet certain regulatory requirements and therefore would not receive the regulatory approval required to sell the product. On February 15, 20X2, XYZ issued a press release announcing the regulator s decision and its stock price immediately declined to $3 per share. Evaluation: The precipitous decline in market value, although occurring only one month after the initial investment, should lead Investor to conclude that the investment is other-thantemporarily impaired. Example 4 On October 15, 20X1, Investor purchased 200,000 shares of DEF stock at a cost of $21 per share. At the end of the first quarter of 20X2, the stock closed at $18 per share. Investor determines that the stock price decline is related to the cyclical nature of DEF s earnings and is consistent with historical trends. Based on Investor s assessment of DEF s forecasted earnings and stock price trends, Investor believes that a market price recovery will occur within the following six to nine months. Investor has the ability and intent to hold the investment for an indefinite period. Evaluation: As the severity of the impairment was slight and there is evidence that, in Investor s judgment, supports a market price recovery up to (or beyond) the cost of the investment within a reasonable period of time, Investor deems that the investment is not other-than-temporarily impaired at March 30, 20X2. EITF Issue No Working Group Report No. 3, p. 21

22 Example 5 In addition to the facts and circumstances assumed in Example 4, assume that at the end of the fourth quarter of 20X2, the stock price closed at $18 per share. DEF subsequently issues a press release reporting increased orders of its products and increases its 20X3 earnings estimate by 10 percent. The stock price responded positively to the news, increasing to $20 by the time Investor issued its financial statements in February 20X3. Evaluation: Prospects of a market price recovery up to (or beyond) the cost of the investment are supported by the partial recovery of the stock price and the reports of favorable financial performance in the near future. As the severity of the impairment is slight and there is stronger and incremental evidence that, in Investor s judgment, supports a market price recovery up to (or beyond) the cost of the investment, Investor deems that the investment is not other-thantemporarily impaired at December 31, 20X2. EITF Issue No Working Group Report No. 3, p. 22

23 Exhibit 03-1B PROPOSED GUIDANCE FOR ASSESSING OTHER-THAN-TEMPORARY IMPAIRMENT FOR CERTAIN DEBT SECURITIES 1. This impairment model is applicable to: (a) debt securities accounted for under FAS 115, and (b) debt securities that are within the scope of FAS 124 and that are held by an investor that reports a performance indicator as defined by the Health Care Guide. For debt securities subject to the scope of Issue 99-20, the investor shall: a. Consider whether the security is other-than-temporarily impaired under the guidance of Issue If the security is not other-than-temporarily impaired under Issue 99-20, the investor shall then determine whether the security is other-than-temporarily impaired under the guidance in Issue 03-1 (Exhibit 03-1B) solely by assessing whether the investor has the ability and intent to hold the security for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the cost of the investment b. Continue to follow Issue for post-impairment accounting c. Provide the quantitative and qualitative disclosures required under Issue The following impairment model is summarized as a flow chart later in this exhibit. Step 1: Determine Whether an Investment Is Impaired. 2. An investment is impaired if the fair value of the investment is less than its amortized cost. If an investment is impaired at the balance sheet date, a determination must be made as to whether that impairment is other-than-temporary (see Step 2). Step 2: Determine Whether an Impairment Is Other-Than-Temporary. 3. In circumstances in which an investment can be contractually prepaid or otherwise contractually settled in such a way that the investor would not recovery substantially all of its amortized cost, 7 an impairment shall be deemed other-than-temporary unless (a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the amortized cost of the investment, which EITF Issue No Working Group Report No. 3, p. 23

24 in certain cases may be to maturity, and (b) evidence indicating that the amortized cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. The investor shall make an evidence-based judgment about the realizability of a market price recovery up to (or beyond) the cost of the investment by considering the severity and duration of the impairment in relation to the forecasted market price recovery. 4. Investor s Ability and Intent. An impairment shall be deemed other-than-temporary unless the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the amortized cost of the investment, which in certain cases may be to maturity. The investor should consider whether its cash or working capital requirements and contractual or regulatory obligations indicate that the investment will need to be sold before the forecasted market price recovery occurs. Although not presumptive, a pattern of selling investments prior to the forecasted market price recovery may call into question the investor s intent. 5. Severity of the Impairment. To evaluate the severity of the impairment, the investor shall assess the extent to which (a) fair value is below amortized cost and (b) the event (or events) that gave rise to the impairment, to the extent identifiable, impacts the prospects of a market price recovery. An other-than-temporary impairment may occur in a very short time after the initial investment or establishment of a new amortized cost basis if, based on all available evidence, the amortized cost of the investment is not recoverable within a reasonable period of time. 6. Duration of the Impairment. Duration refers to the period of time that a security is impaired and the amount of time necessary for a market price recovery from the point of initial impairment. As the length of time that an investment is impaired increases, greater evidence will be required to conclude that an impairment is not other-than-temporary. There are practical limitations on the period of time an investor can incorporate into its forecast of market price recovery, notwithstanding its ability or intent to hold an investment for an indefinite future period. As the forecasted price recovery period lengthens, the uncertainties inherent in the investor s estimate increase, which impacts the realizability of that estimate. Therefore, greater EITF Issue No Working Group Report No. 3, p. 24

25 evidence will be required to conclude that an impairment is not other-than-temporary the further the expected market price recovery is from the point of the initial impairment. 7. Forecasted Market Price Recovery. The investor should consider the following, among other things, in developing an evidence-based judgment about a forecasted market price recovery: A recovery in fair value after the balance sheet date but before the financial statements are issued A favorable change in the regulatory, economic, or technological environment of the investee, including the general market condition of either the geographic area or the industry in which the investee operates Favorable forecasts about the investee s financial performance and near-term prospects, such as earnings trends, dividend payments, asset quality, and analysts or industry specialists forecasts. 8. While the relative weight of evidence should be considered in its entirety, either of the following could individually lead to a conclusion that an impairment is other-than-temporary: a. A recent but precipitous decline in market value, or b. A slight but protracted decline in market value. 9. For investments that cannot be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost, an impairment shall be deemed other-than-temporary if: (a) the investor does not have the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted market price recovery up to (or beyond) the amortized cost of the investment, which in certain cases may mean until maturity, or (b) it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security. In making the determination about collectibility, the investor should consider all information available, including evidence from rating agencies, about market price fluctuations due to factors other than interest rates. 12 Assume that the prepayment option is not required to be bifurcated under FAS 133. EITF Issue No Working Group Report No. 3, p. 25

26 Although not presumptive, a pattern of selling investments prior to the forecasted market price recovery may call into question the investor s intent. 10. An investor may be entitled to the benefits of a guarantee or other credit enhancement related to a debt security that could not be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost. The investor may only consider a guarantee or other credit enhancement in determining whether it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security if: (a) the guarantee or other credit enhancement provides for payments to be made solely to reimburse the investor for failure of the investee to satisfy its required payment obligations, and (b) the guarantee or other credit enhancement cannot be separated from the security. Examples 7-10 in this Exhibit illustrate the application of that concept. 11. Similarly, an investor shall not combine separate contracts (the debt security and the guarantee or other credit enhancement) for purposes of determining whether a debt security could not be contractually prepaid or otherwise contractually settled in such a way that the investor would not recover substantially all of its amortized cost. Example 11 in this Exhibit illustrates the application of that concept. Step 3: Recognize an Impairment Loss Equal to the Difference between the Investment's Amortized Cost and Its Fair Value. 12. If it is determined in Step 2 that the impairment is other-than-temporary, then an impairment loss should be recognized in earnings equal to the difference between the investment's amortized cost and its fair value at the balance sheet date. The fair value of the investment would then become the new cost basis (hereinafter referred to as the adjusted amortized cost) of the investment. 13. The difference between the adjusted amortized cost of the investment and the undiscounted future cash collections that are both reasonably estimable and probable should be recognized as a yield adjustment over the period in which the future cash collections are reasonably estimable EITF Issue No Working Group Report No. 3, p. 26